How does the central bank control credit creation in the economy through bank rate explain Class 12?
Following increase in bank rate, market rate of interest is also raised, implying a check on borrowings from the Commercial Banks. Thus, overall supply of credit is reduced in the economy. Exactly opposite is done to combat deflation: bank rate is lowered to increase the supply of credit. Was this answer helpful?
The Central Bank makes use of Repo Rate to control the supply of money and credit creation. A rise in Repo Rate would make borrowings by commercial banks costly. This increase forces these banks to raise the interest rates on lending to the general public.
Repo rate is used as a main instrument of credit control. When the central bank raises the repo rate, there will be an increase in the cost of borrowing which reduces commercial banks borrowing from the Central bank. Consequently, the flow of money from the commercial banks to the public reduces.
Credit control is defined as the lending strategy that banks and financial institutions employ to lend money to customers. The strategy emphasises on lending money to customers who have a good credit score or credit record.
A central bank can control credit in several ways, including: Setting interest rates: One of the most common ways a central bank controls credit is by setting interest rates. By increasing or decreasing the interest rates, the central bank can encourage or discourage borrowing and lending.
To ensure a nation's economy remains healthy, its central bank regulates the amount of money in circulation. Influencing interest rates, printing money, and setting bank reserve requirements are all tools central banks use to control the money supply.
Bank rate is the rate charged on the loans offered by the Central bank to the commercial banks without any collateral. Bank rate is a quantitative credit control measure under the monetary policy of the government as it controls the overall supply of the money in the economy.
Open market operations refers to buying and selling of securities in an open market, in order to affect the money supply in the economy. The selling of securities by Reserve Bank of India will wipe out extra cash balance from the economy, thereby limiting the money supply resulting in controlled credit creation.
The different instruments of credit control used by the Reserve Bank of India are Statutory Liquidity Ratio (SLR), Cash Reserve Ratio (CRR), the Bank Rate Policy, Selective Credit Control (SCC), Open Market Operations (OMOs).
Direct Credit Control: The Central Bank can direct Deposit Money Banks on the maximum percentage or amount of loans (credit ceilings) to different economic sectors or activities, interest rate caps, liquid asset ratio and issue credit guarantee to preferred loans.
What are the instruments of credit control class 12?
Quantitative Instruments of Credit Control: These methods or instruments are used to regulate the total volume of credit in the economy. Some important quantitative instruments are open market operations, Cash Reserve Ratio (CRR), Bank rate, Statutory Liquidity Ratio (SLR), Repo rate, Reverse repo rate, etc.
Central banks conduct monetary policy by adjusting the supply of money, usually through buying or selling securities in the open market.
Credit control is a business process that promotes the selling of goods or services by extending credit to customers, covering such items as credit period, cash discounts, payment terms, credit standards and debt collection policy.
The central bank plays a crucial role in credit creation by setting the reserve requirement, which is the minimum amount of funds that banks must hold against their deposit liabilities. This determines how much money banks can lend out.
Central banks carry out a nation's monetary policy and control its money supply, often mandated with maintaining low inflation and steady GDP growth. On a macro basis, central banks influence interest rates and participate in open market operations to control the cost of borrowing and lending throughout an economy.
Credit control is a business process that promotes the selling of goods or services by extending credit to customers, covering such items as credit period, cash discounts, payment terms, credit standards and debt collection policy.
The Reserve Bank of India (RBI) controls the supply of money and bank credit. Government securities are purchased and sold in the open market by the RBI to control money supply. This is known as open market operations. You can read about The Reserve Bank of India: Functions and Composition in the given link.
When a central bank raises interest rates, its goal is to slow down the economy. Raising interest rates will increase the cost of borrowing because loans now come with higher interest rates. This makes the purchase of goods and services on credit more expensive.
By maintaining expected inflation equal to its inflation target, money and inflation grow in line with the inflation target. By maintaining the real rate of interest equal to the natural rate, the central bank prevents monetary emissions that force undesired changes in prices.
Bank rate is a quantitative tool of credit control in the economy to control the situation of inflation and deflation whereas rate of interest is not a tool of credit control as it is not determined by the central bank.
What are the two types of credit control?
RBI uses two types of credit control methods for money supply in the Indian economy, Qualitative and Quantitative.
RBI gets to control and coordinate the credit maintained by banks through the CRR rate which helps to have a smooth supply of cash and credit in the economy. When the CRR rate is reduced by RBI, commercial banks can offer more advances to borrowers which in turn increases the flow of cash to the public.
Central banks tend to focus on one “policy rate”—generally a short-term, often overnight, rate that banks charge one another to borrow funds. When the central bank puts money into the system by buying or borrowing securities, colloquially called loosening policy, the rate declines.
Open market operations work by selling and buying government securities by the central bank of a nation. To increase the money supply, the central bank buys back securities, while to reduce the money supply it sells securities to the commercial banks.
By buying or selling bonds, bills, and other financial instruments in the open market, a central bank can expand or contract the amount of reserves in the banking system and can ultimately influence the country's money supply. When the central bank sells such instruments it absorbs money from the system.
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